Changes to the audit requirements for public interest entities (PIEs) take effect on 17 June 2016 under a new EU Audit Regulation and as a result of amendments made to the EU Statutory Audit Directive, implemented in the UK by the Statutory Auditors and Third Country Auditors Regulations 2016.
In addition to credit institutions and insurance undertakings, PIEs include companies with transferable securities admitted to trading on a regulated market (traded companies). This will therefore include companies admitted to the Official List and traded on the main market of the London Stock Exchange, but will not include AIM companies.
Consequential changes will be made to DTR 7, to the UK Corporate Governance Code and the Guidance on Audit Committees published by the Financial Reporting Council (FRC).
Some of the more significant changes are summarised below.
The Companies Act 2006 has been amended, for the first time setting out in statute the role of the audit committee in relation to auditor appointments and providing for mandatory auditor rotation and competitive tendering.
A UK incorporated traded company must retender its audit engagement at least every ten years, unless it is a small or medium-sized enterprise or a company with reduced market capitalisation for the purposes of the Prospectus Directive.
The audit committee must make a recommendation to the board as to the choice of auditor. In years where there has been a tender process, the audit committee must identify its first and second choices in its recommendation, and state that its recommendation is free from influence by any third party and that no contractual restriction on its choice of auditor has been placed on the company.
Following the audit committee recommendation, the board proposes an auditor for appointment by the company in general meeting. The board must include in its proposal details of the audit committee's recommendation and, if its proposal does not accord with that recommendation, the reason for that.
The auditors will be subject to a maximum engagement period of 10 years. This is extended to 20 years if the audit firm was first appointed following a tender process, and was reappointed pursuant to a tender process after a maximum of 10 years. The FRC can, in exceptional circumstances, extend the maximum engagement period by a further two years.
Transitional provisions apply so that where an audit firm has been in office since before 17 June 1994, the company must change its auditors by June 2020. Where an audit firm has been in office since before 17 June 2003 (but on or after 17 June 1994), the company must change its auditors by June 2023.
An audit firm which has reached the end of its maximum engagement period cannot be reappointed as auditor within four years, nor can any person in its network.
These provisions sit alongside the competitive tender process previously imposed on FTSE 350 companies by the Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014, which continues to apply.
Contractual clauses restricting the company's choice of auditor are prohibited, and existing contractual restrictions are void. This prohibition applies from 17 June 2016 to companies which are not PIEs including, for example, a traded company's UK subsidiaries. Technically, it will not apply to PIEs until 17 June 2017. However, from 17 June 2016 the audit committee of a PIE is required to state, when recommending an auditor for appointment, that no such clause has been imposed on it. This means that, in practice, the prohibition will also apply to PIEs from the earlier date. From 17 June 2017, a PIE must inform the FRC if there is an attempt to improperly influence its choice of auditor.
Audit fees and services
Contingent audit fees, calculated on a basis relating to the outcome of a transaction or work performed, are prohibited. Audit firms may not tender for non-audit services valued at more than 70% of the average audit fee in the last three financial years and, if total fees from a PIE for each of the last three financial years is more than 15% of the audit firm's total fees, the audit firm must disclose this to the PIE's audit committee and discuss the threats to their independence.
The audit firm is not permitted to provide certain services to the PIE, including certain tax services, payroll services, services relating to the internal audit function and certain legal and human resources services. Other non-audit services may be provided if the audit firm has properly assessed any threats to its independence.
The audit firm must give an annual written confirmation of independence to the audit committee.
The audit report must include a statement on any material uncertainty relating to events that may cast significant doubt about the company’s ability to continue to adopt the going concern basis of accounting, and the audit firm must deliver a detailed report to the PIE's audit committee along with, or before, the audit report.
The audit firm must report to the FRC any material breach of laws or regulations by the PIE, and doubts about its continuous functioning or the issuing of an adverse or qualified audit opinion.
Removal of auditors
The Companies Act 2006 has been amended so that the court may remove the auditors of a PIE on the application of the FRC, or on the application of shareholders representing 5% or more of the voting rights or the nominal value of the share capital of the company. The court will remove the auditors if it is satisfied that there are proper grounds, but a divergence of opinion on accounting treatments or audit procedures will not be sufficient.
Amendment to DTR 7 and the UK Corporate Governance Code
Consequential amendments to DTR 7 are proposed, to take effect for financial years beginning on or after 17 June 2016:
- The independence requirement will apply to a majority of the members of the audit committee, rather than at least one member.
- The members of the audit committee as a whole will be required to have competence relevant to the sector in which the company is operating.
- The audit committee chairman must be independent and must be appointed by the members of the audit committee or by the board.
- The responsibilities of the audit committee have been extended.
The UK Corporate Governance Code is also amended, for financial years beginning on or after 17 June 2016, to provide that the audit committee as a whole must have competence relevant to the sector in which the company operates. The revised Code also includes a requirement for the annual report to include advance notice of any external auditor retendering plans. The FRC has also updated its Guidance on Audit Committees.
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